Newsletter March 13, 2004


Don’t Just Be Right – Be Rich!

One of the psychological barriers to investing is that we humans often get more satisfaction out of being right than we get out of making gains.

For example many people would feel happier making 15% on each of three stocks than they would of making minus 5% on two stocks and 100% on the third stock. In the second scenario the investor is up a net 90%, while in the first, the investor is up 45%. But in the 90% scenario two mistakes were made while in the 45% scenario no mistakes were made. Most humans get a certain amount of “psychic income” from being right and would actually feel better about the 45% scenario.

We tend to mentally keep track of how many times we were right or wrong, rather than simply focusing on the overall growth of our portfolios. And we want to avoid being wrong. If we own a stock and it falls on bad news, then we are reluctant to sell and admit we were wrong to buy it (even though it may have been a good decision based on the information at that time).

We should think about doing what is best for our overall portfolio, not about how many individual winners and losers we have. It might be smart to sell a stock that you think will gain 10% in a year to move into one that you think will gain 30%. If that happens then you were not wrong to sell the first stock even if it did end up going up 10%.

Stock Market Direction

I don’t claim any ability to predict the overall direction of the market. However we have had a strong run until this week’s setback. The market is generally acknowledged to be at least fully, if not over-valued. So…it would not be surprising at all to get a 10% or more decline. Off-setting this, the economy still appears to be reasonably strong, corporate earnings have been strong, interest rates have been declining and investors are generally more willing to hold equities. In Canada, we have an additional up-side force as more companies convert into income trusts. Overall, I am hopeful that the market will be higher by the end of this year. However, high market returns can not last forever and if it is higher at year end then it will be priced to yield only about 7% on average after that. Remember bonds rise with falling interest rates but then give low yields based on low interest rates after the rise. Stocks are subject to exactly the same force except the pattern is obscured by a lot of other factors driving stock prices.

Canadian Stock Market Sectors

All TSX sectors are up strongly in the last 12 months. Among the weakest (but still strong) are Golds, Health, Consumer Staples and Utilities which returned 20 to 25% in the past 12 months (I believe these figures exclude dividends). Most sectors were up 25% to 50% while the metals & minerals sector was up 78% and the Information sector (which excludes telco) was up a whopping 123%). This data is from today’s Financial Post.

If you want to concentrate in investing in a particular sector then you could use a mutual fund, particularly if you feel that a certain mutual fund manager has a great track record and should continue to out-perform.

Exchange Traded Funds

If you like a certain sector but don’t know which mutual fund to choose, then an exchange traded fund can be very effective since the management fees that you pay can be easily 2% less. This gives you a head start on the mutual fund managers.

You can find a list of exchange traded funds on the TSX at

Unfortunately, not every sector has an exchange traded fund. Canadian sectors that I would be interested in include, the overall composite index, the financial index, the energy index and the Real Estate Investment Trust Index. Many of these indexes are available in two versions – regular or capped. The capped index limits any one stock to (I believe 10%) of the index so that you do not get ever-exposed to any one company when you are trying to be diversified.

Investing through exchange traded funds allows you to get good diversity while holding only a very few funds and you avoid the high fees of mutual funds. I also like exchange traded funds because you can move a lot of money in or out of the market with good liquidity and at a low trading cost.

In my own case I rarely use exchange traded funds because I prefer to pick individual stocks.

A close cousin of exchange traded funds is index mutual funds, these are designed to track a certain stock market index but are mutual funds rather than exchange traded funds. The management fees are higher than exchange traded funds but lower than most mutual funds. Unfortunately I have not found a list of such index mutual funds.


Here is a link to my articles on picking individual stocks

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Performance is very strong and is updated through March 12, 2004.

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